• Fintech Brainfood
  • Posts
  • Fintech 🧠 Food - 21st Aug 2022 - Everyone hates Flow, Fed Master Accounts and Nubank keeps crushing it.

Fintech 🧠 Food - 21st Aug 2022 - Everyone hates Flow, Fed Master Accounts and Nubank keeps crushing it.

Hey everyone 👋, thanks for coming back to Brainfood, where I take the week's biggest events and try to get under the skin of what's happening in Fintech. If you're reading this and haven't signed up, join the 19,728 others by clicking below, and to the regular readers, thank you. 🙏

Hey Fintech Nerds 👋

The world is united in agreement that WeWork founder Adam Neumann getting funding at a $1bn valuation is horrific. Life is rarely that black and white; I do think there’s more going on here than meets the eye and make the case in this week’s Rant.

Don’t get me wrong, I agree with much of the criticism. Much of which pointed out a white man has failed-up while underrepresented founders continue to be massively underrepresented. But if you stand back and look at Flow, some genuinely interesting things are going on that warrant a sober consideration, however awful the optics are.

So suspend the frustration, and let’s take a look at why it might be time to Rent-to-own.

PS. I’m at Devcon this week. Likely at many of the happy hours. Drop a reply to this email if you want to say hello

Weekly Rant 📣

Flow - It's time to Rent-to-own.

The vast majority of consumer wealth creation comes from home ownership and the 401k. Yet, asset prices have soared ahead of wage growth for decades, compounded by a cost-of-living crisis and inflation. 

Asset prices rising faster than wages raises inequality and limits opportunity for people from low-income backgrounds. Actual diversity creates cognitive diversity, which per the OECD (and countless other studies), increases growth for businesses and the economy.

Fixing social problems is the right business case for an economy. Not because it's a nice thing to do and feels good, but because it improves the entire economy.

We need innovation to make more people owners.

It's time to build.

Or perhaps, it's time to rent-to-own. 🤔

a16z has invested $350m into Flow, which will buy properties and allow "renters to receive the benefits of being owners." The blog post is limited in detail, so based purely on speculation (and a significant h/t to this thread), here's what might be happening.

  • In Jan 2022, Adam bought 3000+ apartment units valued at $1B+ in Miami, Atlanta, Nashville, Tennessee, and other cities. 

  • Invested in Valon Tech, a digital mortgage lender, and servicer from his family office

  • Invested in Hello Alfred, a digital property manager helping with rent payments, maintenance, deliveries, and community events

  • And invested in Doorsey, a real estate listing service that focuses on "open bidding," where buyers are transparently shown current offers for a property.

These companies may not get rolled together, but when you take those pieces, you can see a larger puzzle emerge. Gen Z can live in more affordable cities, with much more convenience, and possibly even move between residences while building equity (e.g., some level of "Airbnb" functionality like a WeWork membership to other clubs). 

As always, with this type of news, many seemingly contradictory things are true at the same time.

  • The need is real: Younger generations need rent-to-own and would value a better living experience and flexibility.

  • There is a case for Neumann as a founder: Neumann did change the office rental experience for start-ups and built a multi-billion dollar business.

  • There are lessons to take from WeWork: But trying to do it at venture speed and scale meant it fell back down to earth, and lessons must be learned.

  • Big VCs aren't just VCs anymore: We're seeing VCs become more like PE funds looking at real estate as a long-term place for capital.

  • We need more solutions for wealth creation: None of this solves the housing market's fundamental lack of supply issue.

And yes, the timing of this investment after Marc Andreessen also blocked a proposal to build new properties in his neighborhood is tone-deaf.

The case for Neumann as a founder

The WeWork story is often a tale of tech hubris. 

WeWork was a start-up valued at $47bn that later went public for just $8bn with a founder who wanted to "elevate the world's consciousness" and invented his own controversial financial metric, "community-driven EBITDA." 

But before WeWork, super early start-up office space was limited to working in a garage, co-working spaces in major city hubs, or soulless corporate offices like Regus.

Perhaps the main player was RocketSpace, but they didn't operate at nearly the scale of WeWork. Today WeWork has 777 locations in 38 countries, with 615,000 memberships. In their Q2 results, WeWork is projecting a ~$3.4bn full-year revenue with a net loss of $400m adjusted EBITDA.

How many companies can you name that had or currently has a WeWork office or a few staff working from a WeWork office? WeWork brought the Google and Facebook campus feel to early-stage entrepreneurs. 

Neumann and WeWork changed the landscape and the experience for many. Whichever way you look at it, WeWork is a multi-billion dollar company in public markets, generating billions annually. 

The lessons to take from WeWork

1. Property isn't the same as software: Neumann often sold WeWork investment as "more like investing in software." Software averages a 16x revenue multiple and scan scale incredibly fast because it is easily copied and distribution costs are near zero.

Property is expensive (and slow) to build, buy and maintain.

Property can be dramatically enhanced with the software, but it isn't the same business model.

2. Growth at all costs doesn't work in Real Estate: One of WeWork's most prominent backers, Softbank is known for telling its companies to grow at all costs. And that's what WeWork did. Taking on new leases rapidly, ahead of rental incomes. WeWork opened new offices in new cities at an incredible speed, but it took on significant cost commitments as it did so.

A commercial RE lease has a typical minimum 3-year commitment and an average of 5. WeWork then re-sold the space to members with a minimum of a one-month commitment. Unless it hits a high occupancy level on every one of its spaces, WeWork will never be profitable. Post-pandemic and in the public market, WeWork has stopped opening offices and closed many. 

3. Having investors who understand Real Estate is critical: Commercial Real Estate is historically low volatility and has lower returns than venture capital. Commercial RE isn't a bad investment; quite the opposite, it is consistent and delivers solid (often inflation beating) returns yearly. But VCs look for 10x in 7 years, not 10% annually. 

Having Masa-Son and the VCs pushing WeWork to grow at all costs may have changed the landscape of start-up office space, but it also very nearly drove the company insolvent. 

But like everything with a16z, I get the sense this investment has been made knowing the realities above and is still made with the intent for growth. Just not venture growth.

Big VCs are moving beyond venture.

If the last cycle proved anything, there was too much venture cash chasing too few deals. The biggest names in the venture have all raised so much it would be impossible to deploy as $10m or even $50m checks in the lifetime of a standard venture fund.

Real Estate is an asset class that can comfortably swallow hundreds of millions of dollars in a single investment. More diversified private equity and asset managers like KKR, Blackstone, Apollo, and TPG comfortably manage 100s of $billions, if not $trillions, and generate consistent returns for their investors. Many big investors (like pension funds and sovereign wealth funds) may already be allocated to those prominent VCs, so this type of diversification becomes a natural extension of the investor-to-fund relationship. 

Rent-to-own won't fix the property market.

But it will help a generation in need of a leg up.

Asset prices are still far too high compared to real wages. Home buyers' rule of thumb was that a house should cost ~2.5% of your annual salary. But in most cities, that is an unachievable reality. Even historically affordable cities like Nashville see a median house price of $460k with a median income of $74k (6.1x salary). 

As interest rates rise, property values shouldn't grow as quickly as they did historically (because mortgages become more expensive and the demand to buy houses should decrease).

 But the net effect of that on younger consumers is 

  1. Even if you do work incredibly hard to buy a property, now your income isn't growing as fast as inflation

  2. And your property value isn't growing as fast as it was historically

  3. And when you renew your mortgage, it's likely to cost more per month than it does today

  4. On top of the cost of everything increasing

This is why many consumers have side hustles and work in the gig economy. It's wrong to have to work hard for success; it's wrong to not be able to afford to live even if you do work hard. 

The reality is people have to live somewhere, and why shouldn't paying rent not only benefit my credit score but also help me build wealth over time? This should be the new normal.

We need more solutions for consumer wealth creation in addition to rent-to-own. We need a world where we can all become owners, breaking much of the web2 and gig-economy business model where the consumer is the product. 

Perhaps having more patient capital that is investing long term is a good thing then. Real estate might not generate venture returns in venture time frames, but it still needs disruption as do many "real world" industries.

Whatever your thoughts on WeWork or Neumann, I believe Flow is directionally correct and a sign of things to come.

But we also need much more to solve income inequality long-term. 

It's time to build wealth for consumers. 

Because then everyone wins.


4 Fintech Companies 💸

Defacto - An API for embedded finance 

  • With Defacto developers can offer buyers pay later at checkout, instant payouts to sellers, and financing the entire SMB's "wallet." Defacto connects to tools like Quickbooks and Stripe to allow either white-labeled or branded lending.

  • 🤔 I clicked around on the website, but I can't find who's providing the capital for this (which is probably a regulatory issue). I sense Defacto is still early, and this is very much a tech demo, but it's a well-done tech demo if that's the case. All of the usual caveats about lending and marketplaces apply. Lending is much more complex than payments because so much can go wrong. 

Keese - The CFO Operating System

  • Keese automatically identifies currency exposure from past and upcoming expenses. Users can move cash between local subsidiaries, lock in currency rates for 1 year (FX Forward), and receive more competitive B2B FX rates than most banks. 

  • 🤔 If we're moving to a default global world, then managing FX will become a default skill CFOs need. As companies grow, they need legal entities in more markets, and the job of moving cash between these entities becomes a full-time department in the largest global companies. Large retailers and global corporates treasury teams integrate their systems (ERPs) directly with countless banks and work to make the most of market changes. Growth companies may now have an alternative.

Pastel - Bookkeeping for Nigerian Businesses

  • Pastel competes with paper ledgers and sales records for small businesses in Nigeria and replaces them with the Sabi bookkeeping app. The Sabi receipts app can generate receipts and invoices and creates payment reminders.

  • 🤔 In a world of everything is an expenses card, it's refreshing to see such a pure-play focus on solving the largest problem businesses have, tracking everything. It's unclear how Pastel will monetize, but you could see how they could quickly go into payments, lending, or partnerships for lending. 

Arc - Revenue financing and Full Stack Banking

  • Arc provides up to $50m in funding for start-ups, growth companies, and e-commerce businesses secured against their future revenue. It also provides deposits, cash management, and (soon) corporate cards. 

  • 🤔 The "non-dilutive" revenue-based finance model has proven popular with growth start-ups because it's data-driven. Businesses link their accounting, payments, and advertising data which gives a level of confidence to underwriters on future cash flows. While major players like Clearco and Pipe have focussed tightly on this niche, Arc uses it as a wedge to move deeper into Cash Management and go full stack.

Things to know 👀

  • Nubank added 5.7m customers, growing to 65.3m (57% YoY), with an activity rate of 80% and primary bank status for 55% of their customer base. Cost per active customer was $0.80 per month, and non-performing loans averaged between 3.7% and 4.1%. The business now has $13.3bn in deposits and delivered $635.9m in revenue, with a net loss of $66.2m.

  • 🤔 To be able to grow the customer base by 57%, enter new markets, and launch new products and nearly half the operating loss is an incredible performance. Nubank is hitting its stride and may have much more growth ahead, even with 65 million customers.

  • 🤔 Nubank, by revenues, is ~5th largest bank in Brazil, although it has some way to catch Itau Unibanco's $391bn in assets. Long-term banks are measured by their ability to grow the asset book. But, given it operates primarily in consumer (and lower income segments), that's still impressive. Where might they be in a decade?

  • 🤔 Nubank has benefitted from Brazil's interest rate environment and the lack of competition from the major banks historically. But now, with 100s of copycats, big tech companies, and billions of VC dollars pointed at Brazil and LATAM, that can no longer be an excuse for their success. Their success is the combination of their timing and their execution. The execution especially is a story that needs to be told more. They could be the Netflix or Google of their cohort, throwing off open source projects for the industry.

  • The Federal Reserve has set out how it will review requests by Fintech and Crypto companies to access its payment and account services. Firms already FDIC-insured will have a streamlined process to access payment systems. Firms that are not yet insured and not covered by banking regulators would undergo "stricter review." 

  • 🤔 Today, Fintech companies can't compete with banks to offer payment services like FedWire, but must go through an existing bank partner. Accessing the master accounts would also give Fintech companies the safety net that today requires a bank partner. Reading between the lines here, the Fed says that if you want access to the same protections as banks, you should expect the same scrutiny. Honestly, I don't think that's an unreasonable position.

  • 🤔 Consider this move alongside the scrutiny many partner banks, Fintech companies, and BaaS providers are under for offering "FDIC-insured" accounts to consumers. You could argue Fintech companies have played fast and loose with that term and may be forced to walk it back. But I'd also argue consumer Fintech companies have been a net positive, creating competition, choice, and better products. Would banks have done earned wage access or alternative underwriting on open banking data? Probably not.

  • 🤔 If the "FDIC-insured" via partner banks loophole Fintech companies use goes away, then having a path to be FDIC-insured and have master accounts creates a level playing field. But it's only level if Fintech companies can get through this processI worry that, like Fintech companies currently trying to chartered, many will try and fail. Some because they haven't got their regulatory act together, but others because the mood music in regulator land is anti-Fintech, and that's worrying.

  • 🤔 This doesn't mean the floodgates will open. The Bank of England opened access to its master accounts and payment systems to Fintech companies in 2017. So far, a handful has succeeded (like Wise and Railsr), but it hasn't changed the UK market dramatically. My advice to Fintech companies here is to be careful what you wish for and be prepared for a long journey. 

  • 🤔 A good friend Alex pointed out on LinkedIn that the economics of going direct to the central bank in the UK only made sense at certain volumes. He gives the metaphor of Fintech companies who build their card issuing or acquiring integration in-house. The upfront capex is high, but if there’s enough volume, it can make strong unit economics. 

Good Reads 📚

  • The argument that poor security or cost has kept consumers away from Crypto doesn't add up to this author. Pointing out that Facebook has had hacks and retains 3 billion users, Twitter and Instagram baffled users at first. The issue is the idea that tokenomics are a business model. Many of the best examples of Tokenomics (like Chainlink) are not consumer-facing, and many of the best consumer token projects end as speculative bubbles.

  • The issue is that tokenomics rewarded speculation, not engagement, even with services like Stepn. A possible exception is Pooltogether, which rewards users with a lottery the more they save and engage. People play games, listen to music, and want to engage with their fans; what is the reward flywheel for doing that?

  • 🤔 If web2 was about ad-supported subscriptions, are there new business models for web3? The x-to-earn models like play-to-earn or walk-to-earn provided incentives but only worked while the token price went up. But people play and walk daily with the intrinsic reward from the game or step counter as the only motivation. Maybe incentives for doing something aren't the right approach, but more value for the thing you're already doing.

  • 🤔 If there are new business models, they are likely to involve turning data into a proper commodity (and asset). The classic line "data is the new oil" turned out to be true if you look at the growth in the data barons like Meta and Google. It's unrealistic to expect those businesses to unwind all their data on consumers. But in the same way, I can go to Dune.xyz today and see the daily volume on Opensea or with Stablecoins. Can you imagine consumers having a dashboard of all their game assets, media assets, finances, and property? Once data is modeled in the web3 sense, it becomes incredibly interoperable.

Tweets of the week 🕊

That's all, folks. 👋

Remember, if you're enjoying this content, please do tell all your fintech friends to check it out and hit the subscribe button :)